Big Trucks for Big China

“The recent economic improvement in China, India and Brazil benefitted Cummins during the quarter, due to our longstanding strong position in all three countries.” –From Cummins Inc.’s third quarter earnings report

Though hours of service (HOS) reform is bound to be the hot topic around water coolers across the U.S. trucking industry in the weeks and months ahead, another trend is happening up that could lead to even bigger changes and on a global scale for the trucking business – the movement of U.S.-European-Japanese level truck technology into burgeoning foreign markets such as Russia, India … and China.

This is a trend I reported on a while back, based on an analysis of China’s truck market by research firm Frost & Sullivan entitled Strategic Analysis of the Chinese Commercial Vehicle Market.

Sandeep Kar, program manager & senior industry analyst with Frost & Sullivan’s North American automotive & transportation practice, told me at the time that China’s truck manufacturers are increasingly looking to forge partnerships with U.S. and European truck OEMs to gain design expertise in fuel economy and emission control systems in order to meet a rapid series of changes to their business.

Kar said Chinese demand for new heavy trucks – those with gross vehicle weights of 14 tons or more – will climb due to several factors. The first is new “charge-by-weight” laws that severely penalized overloaded vehicles; rules that should force many Chinese truck owners to upgrade from medium trucks (with GVWs of six to 14 tons) to heavier models capable of legally hauling heavier loads.

The second is a boost in diesel fuel taxes from 1 cent to 11 cents per liter, he said. That move will drive demand for more fuel -efficient engines, Kar said. Finally, the harmonization of Chinese truck emission rules with those of the U.S. and Europe – expected to occur in stages between 2010 and 2012 – will boost demand for emission control systems.

All of this will help drive yearly heavy truck sales to levels far in excess of North America volumes, Kar (at left) explained to me. “Right now, the North American Class 8 market is hovering between sales of 100,000 and 150,000 annually,” he said. “Chinese heavy-truck demand will be in the range of 500,000 units annually; more than five times the volumes currently seen in North America.”

Those kinds of numbers are getting the attention of North American OEMs, for sure. While engine makers such as Cummins Inc. established joint ventures in China some time ago, Navistar is now jumping into the game with both feet, announcing that they are in talks with Anhui Jianghuai Automobile Co. Ltd. (known by the acronym JAC) to explore a potential engine joint venture to develop, build and market advanced diesel engines for commercial vehicles in China.

The potential joint venture, if formed, would have a 50/50 ownership between Navistar and JAC, with a shared research and design center in China’s Anhui province for application engineering development, product design and technology advancements. Diesel engines produced by the new venture would primarily be used in China, as well as certain export markets, Navistar added.

The lure of China, of course, is high production volumes – the kinds that could end up helping lowering the costs of emission control system components back on this side of the big Pacific "pond." China’s commercial truck production is projected to expand from 1.92 million annual units in 2008 to over 2.68 million units by 2015 – resulting in a compound annual growth rate of 4.9%.

Frost & Sullivan's Kar told me that these numbers are critical in that economies of scale gained from such joint ventures could lower the global cost of producing emission control system components – possibly leading to price reductions for such system from U.S. and European truck markets.

“How do OEMs get economies of scale today? They can’t in their local markets – truck [sales] volumes are low in Europe and the U.S.,” he explained. “So you must take your technology abroad to markets that are growing. That not only gives you economies of scale but a way to test out technology as well; all while helping top and bottom line revenue look better and better.”

That’s a huge deal to U.S.-based OEMs such as Paccar, which builds Peterbilt and Kenworth branded trucks fmainly for the North American market and owns European truck maker DAF – and Paccar’s outlook for the European and North American truck market is tepid, to say the least.

“The estimate for 2009 industry sales in the above 15-tonne truck market in Europe is 170,000-180,000 units, reflecting ongoing challenging economic conditions throughout Europe,” noted Aad Goudriaan, DAF’s president, in Paccar’s third quarter earnings statement. “As expected, economic recovery in Europe is lagging North America with truck sales in 2010 anticipated to be in a range of 150,000-180,000 units, similar to industry sales in 1992.”

“Class 8 industry retail sales in the U.S. and Canada are expected to be in the range of 100,000-110,000 vehicles in 2009, reflecting continued economic weakness, particularly in lower housing starts and auto production,” added Dan Sobic, Paccar’s executive vice president. “There are some mildly encouraging signs as freight tonnage has recently started to increase and the ISM Manufacturing Index has exceeded 52.0 in each of the last two months, the highest readings since July 2007. Our customers are also benefiting from lower fuel prices and good availability of drivers; though freight rates and tonnage are lower than last year.”

However, Sobic noted that U.S. and Canadian retail sales for Class 8 trucks in 2010 are expected to improve only slightly, due to the aging of the fleet and general economic growth, to a range of 110,000-140,000 units. “That’s still below normal replacement demand of 225,000-250,000 units,” he said.

And that kind of dramatic cratering of new truck demand is hitting truck OEMs hard. Paccar, for example, earned just $13.0 million on revenues of $2 billion for the third quarter this year – compared to net income of (get this!) $299 million in the third quarter last year. That’s a falloff in profit of almost 96% if I’ve done the math right. For the first nine months of 2009, Paccar earned $65.8 million on revenues of $5.83 billion – a VERY far cry for the $904.8 million in profits the OEM book in the first nine months of 2008.

Cummins is in the same boat, with net income in the third quarter falling 59% to $95 million on 31% lower sales of $2.53 billion, respectively, compared to the third quarter in 2008. While the company attributed much of its improved profitability and cash position from the second quarter to lower spending, better utilization of manufacturing capacity and reduced inventory, a 4% increase in sales to China, India, and Brazil helped out as well.

That’s critical going forward, for while Cummins reported an increase in engine and components sales to the medium- and heavy-duty truck engines markets in the U.S. in the third quarter compared to the second quarter in 2009, based on current orders and market intelligence, the company expects very low demand in these markets during the first half of 2010.

“While we saw improvement in some markets in the third quarter, we expect the economic climate to remain challenging until late 2010 – especially in the U.S. and Europe,” said Tim Solso, Cummins' chairman and CEO, in the company’s third quarter report. Even though he noted Engine joint venture revenue and profits in China declined due to lower demand compared to year ago, things may be starting to trend back up due to that nation’s own aggressive “stimulus” spending.

Buoyed by nearly $1.3 trillion of stimulus money, the Chinese economy is starting to recover, and recover quickly, from the global recession. GDP for the country jumped 7.9% year over year, far outpacing what analysts expected, according to a story filed about a month ago by my editorial compatriot Brian Straight.

He noted a new report by ACT Research in combination with China’s State Information Center indicates second quarter medium- and heavy-duty truck sales climbing 67% in 2009 over the second quarter of 2008.

“A lot of it had to do with China having a massive stimulus program, much like ours, but much larger,” said Ken Vieth Jr. (at left), ACT partner and senior analyst. Vieth added that the dump truck market is doing particularly well, with recent reports indicating a rise in retail sales in China also. [You can find more data in the firm’s China Commercial Vehicle Demand Outlook.]

In the second quarter of 2008, China implemented more stringent emissions requirements, spurring a pre-buy in the first half of the year, Vieth said. In the second quarter of 2008, China saw sales of 288,100 vehicles before the economy’s troubles worsened. In the third quarter, the number dropped to 140,000 and even further to 113,000 in the fourth quarter before rebounding slightly in the first quarter of this year to 143,000.

Still, with sales of 239,000 in the second quarter, it appears the market is booming. “China has become the colossal commercial vehicle market today,” Vieth said. “China has slowly worked its way into a 600-pound gorilla. There used to be three 600-pound gorillas: North America, Europe and Japan. Now, China is bigger than them all.”